RECENT DAYS have witnessed some extraordinary developments, most of them from the Bank of England. Time was when months would go by without a peep from the Old Lady. Now it has become a news-generating machine that Max Clifford would be proud of.

Development one was Mervyn King’s attack on the City’s reward culture, which many will applaud, though some would say a bit of performance-related incentive is a good thing. The governor’s salary of just under £282,000 — small in relation to many City salaries though with a pension pot of nearly £4m — rises 2% a year, come what may. That gives him an incentive to keep inflation on target but doesn’t reward or punish him beyond that.

Development two was a speech by David “Danny” Blanchflower, one of King’s colleagues on the Bank’s monetary policy committee (MPC). This was, it is safe to say, the most doom-laden speech ever from a UK policymaker, warning that Britain was likely to follow America into recession (whether the US is in recession is still open for debate after first-quarter numbers showed growth), that a fall in house prices of a third in two to three years “does not seem implausible” and the risk of something “horrible” arising from the credit crunch was significant.

Compared with the coded language normally adopted by anybody with anything to do with the Bank, this was a revelation. Blanchflower spends half his time in America and that may explain his gloom, but even there central bankers are a bit more guarded in their language. I am surprised this one got past the censors.

“Developments in the UK are starting to look eerily similar to those in the US six months or so ago,” he said. “There has been no decoupling of the two economies: contagion is in the air. The US sneezed and the UK is rapidly catching its cold.” I’ll return to that.

Development three, hard on the heels of this blood-curdling warning, was the apparent declaration from the Bank that the credit crisis was over and that banks should come out of their shells and start lending again.

This was not quite what its financial stability report was saying: that some gloom in financial markets may have been overdone, in that the scale of losses assumed in US sub-prime assets, a 40% default, looks too pessimistic. Financial markets are assuming many such assets are worth nothing, while on conservative assumptions, and allowing for further falls in American house prices, they are worth something.

The broader message was that the authorities could win one battle, to stabilise financial markets, only to lose a bigger one, that of stabilising the economy,

The Bank thinks lenders, worried about bigger losses in asset-backed securities than are likely, could be entering overkill territory in scaling back activities, leading to “a self-fulfilling adverse cycle”. We saw some of this in March, when lenders were falling over themselves to turn away business, and mortgage approvals slumped to 64,000, a record low. As I have noted before, if the banks tighten too much, they risk turning even Blanchflower’s extreme gloom into reality.

How serious should we take his warning that where America leads, Britain follows? I was surprised he used the house price /earnings ratio as the basis for predicting that properties could lose a third of their value. Steve Nickell, his former MPC colleague, did an effective demolition job on it three years ago, and few serious analysts believe the crude ratio is a useful valuation measure.

Constraints on housing supply (with housebuilding rates now in decline), more earners per household, lower mortgage rates, lower long-term real interest rates and other factors explain why the ratio of house prices to average earnings has risen. It probably has risen too much, but there is no good reason to believe it will return to its historic norm, established in very different economic and social circumstances.

As an aside, and I am not including Blanchflower in this, I get fed up with commentators who write that if the International Monetary Fund says house prices are overvalued by 30%, prices have to fall 30%. Basic maths tells you the required fall, if you accept the IMF’s numbers, is 23%. Try it on a calculator. Given that the IMF said it could not explain 30% of the rise between 1997 and 2007, the “required” fall is smaller — under 20%.

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